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Friday, July 19, 2013

Detroit files for Bankruptcy

Yesterday, the city of Detroit filed for bankruptcy. This was not a huge surprise. This Washington Post article provides nice background. For those who prefer numbers to words, the article also provides some nice figures.

One of the figures they present is the city's General Fund Deficit. This is a key variable Marc Joffe and I identified in our ongoing work on municipal default risk. The Washington Post reports a general fund deficit of nearly $600 million. I'm not sure this figure is correct, but Detroit's general fund deficit is certainly large. According to data from Detroit's Comprehensive Annual Financial Report from 2012, "At June 30, 2012, the General Fund had a total fund balance deficit of $269.5 million..."

To put this into perspective, in 2012 Detroit had general fund expenditures of nearly $1 billion. In other words, Detroit's General Fund Balance divided by its General Fund Expenditures was -0.27. This is a very large negative ratio!

Given this large and negative ratio, it is not surprising that Detroit filed for Bankruptcy. In 2011, only four cities in California had a negative value of this ratio and one of them (San Bernardino) declared bankruptcy the following year. The other California city to declare bankruptcy in 2012 (Stockton) had a positive but very small value of this ratio--of the 261 largest cities for which we had data, only ten had a smaller value of the general fund balance to general fund expenditure ratio.

In addition to looking at the general fund balance variable only, we also presented two additional models for predicting municipal default risk in our revised report (which we hope to release in the days ahead). One of these models estimates Detroit's default probability score to be 3.34%, which is higher than about 98% of California cities we studied.

The other model we developed was based on analysis of Great Depression-era defaults (a lot of cities defaulted back then). This model puts Detroit's default probability higher than all California cities!

While I'm happy that our models do a remarkably good job of predicting Detroit's bankruptcy, my heart goes out to its people. I trust that brighter days lie ahead.